Retirement accounts (like IRAs, 401(k)s, and pension plans) are often one of the biggest assets in a divorce. Many people going through a divorce worry about losing their retirement savings, especially if they are nearing retirement age.
If you are going through a divorce, you may be asking yourself, "Is there any way I can keep my pension?" The answer is yes. But only if you "buy out" any marital interest your soon-to-be ex-spouse has in the pension fund.
How Does a Pension Work?
Pension plans are unique because they promise to give employees a set amount of retirement benefits for life. Pension plans are also called defined-benefit plans. Unlike defined-contribution plans such as 401(k)s, employees do not have a role in contributing to the funds. Instead, employers are responsible for making contributions on the employee's behalf. Earnings on these investments then fund income for the employee during retirement.
Traditional pensions are not as common as they once were. Today, public sector employers tend to offer pensions while private sector employers tend to offer 401(k)s as retirement plans. Common types of pensions include:
If you have a pension, you will want to read the below information on how to best protect it during your divorce.
How Are Pensions Usually Divided or Split in a Divorce?
Generally, a pension earned during the marriage is joint marital property and subject to the division of assets. There are two ways state law separates marital assets: community property and equitable distribution.
Any part of the pension earned before the marriage can be non-marital, separate property. Separate property is not divided during divorce. However, your ex-spouse could have rights to the amount contributed to your retirement accounts during your marriage.
The state that you live in will determine how to handle pensions in the property division and any pension rights of your ex-spouse.
Will You Lose Half Your Pension During a Divorce?
Before you assume that you will lose half of your pension in your divorce, keep in mind that a pension is usually only one piece of the pie when it comes to a divorce settlement. It is possible for you to keep your entire pension during the division of assets. This could include exchanging a different asset of the same value as your pension plan. Other financial obligations like alimony and child support could also factor when negotiating the separation of assets.
Factors That Need Consideration
If all or a portion of your pension is marital property, there are a few different factors to consider when deciding how to handle the property distribution part of your divorce:
The Details of Your Plan
You will want to understand the details of your pension plan before agreeing to anything with your pension in a divorce settlement. This may include how to distribute your benefits and whether your plan includes a surviving spouse benefit.
For example, you may have the option to receive your pension-defined benefits in a lump-sum payment or monthly. Your plan might also have a single-life payout where monthly payments would stop at your death. Or your plan may have a joint-life payout where payments would continue until your spouse's death.
For example, military pension plans may have survivor benefits. This type of plan ensures that payments beyond the retiree's death will continue to a beneficiary, which may include a former spouse or children.
You need to understand the details of your specific plan before negotiating a property settlement.
How Are Pensions Usually Calculated During a Divorce?
Generally, there are two ways to treat a pension or retirement assets in a divorce. One way is for both parties to agree to share the monthly annuity payments (or lump-sum payment) during retirement. The other way is to divide the value of the pension at the time of the divorce.
Either way, it's important to know what the pension is worth — whether it's the present-day value or what the benefit will be during retirement.
There are special formulas that can be used to figure out both. The calculations can get complicated, especially if a portion of the pension is non-marital because it was earned before the marriage. You can use an online service to calculate the present value of the pension or get this information from an accountant or actuary.
If you and your former spouse choose to divide the present value of the pension, you can decide to offset your spouse's share of the pension with other assets, such as equity in the marital home. This "buy out" method is common.
Qualified Domestic Relations Order
Pensions are not automatically divided in a divorce. Usually, the spouse awarded part of another spouse's pension must obtain a qualified domestic relations order (QDRO) to submit to the pension plan administrator. A QDRO informs the plan administrator how to divide the pension benefit when the time comes.
A QDRO is handled after a divorce is finalized, so it's important not to let this task go undone (especially if you are the spouse receiving the retirement benefits).
Note: Pensions for federal employees use something called a Court Order Acceptable for Processing (COAP) instead of a QDRO.
For the most part, property transfers "incident to divorce" are tax-free. Not all assets carry the same tax implications. After applying taxes, two assets that appear to have similar market value could be very different.
For example, let's say one spouse gets real estate with $300,000 in equity as part of their property settlement, while the other spouse gets $300,000 in other assets. The spouse who got the home may face a capital gains tax if they decide to sell the home, making the settlement unequal.
In the case of pensions, tax applies when the monthly benefit is paid during retirement. Therefore, it is wise to take the anticipated tax burden into account when figuring out an equitable property split.
A Lawyer Can Help Protect Your Pension
Going through a divorce is stressful. Not only is an important relationship ending, but your assets and property must be split fairly. You may worry about your finances, and you could resent having to "share" your retirement savings with your ex-spouse.
An experienced family law attorney in your area can give you legal advice to help you reach a divorce decree that protects your future.